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Stimulating Depreciation Deductions For Your Sign Business

Greater flexibility for depreciating your equipment could be to your advantage.

By Mark Battersby

Depreciation is an allowance for the wear and tear, the natural deterioration or the technical obsolescence of the assets and property used in a sign business. It is nothing more than spreading out the original cost of those business assets over their estimated life. The problem occurs attempting to match the depreciation allowance with the sign operation's income to achieve the maximum tax benefits.

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  • Fortunately, the depreciation deduction is quite flexible. In fact, many sign professionals can utilize the depreciation rules and deduct the cost of improvements made to "leased" property, whether rented business premises or special equipment that is modified by the sign business leasing it.

    Thanks to the Job Creation and Worker Assistance Act of 2002 (H.R. 3090), sign professionals are now entitled to an additional first-year depreciation deduction equal to 30 percent of the adjusted basis of qualified property such as equipment, software and even the cost of improvements to leased property. The 30 percent "bonus depreciation" is allowable for regular and alternative minimum tax (AMT) purposes for the year in which the property is placed in service.

    Generally, an asset must be acquired by the sign operation after September 10, 2001, and before September 11, 2004 in order to qualify for the new "bonus" depreciation. Original use of the property must commence with the sign business on or after September 11, 2001, and the property must be placed in service generally before January 1, 2005. The basis or book value of the property and the depreciation allowances in the year of purchase and in later years must be adjusted to reflect the additional first-year depreciation deductions.

    If, for example, a sign business acquires qualified property, whether equipment, software or leasehold improvements, on June 1, 2002, at a cost of $20,000, the sign operation may claim a first-year depreciation "bonus" of 30 percent of the property's adjusted basis. That's a $6,000 deduction. What's more, the sign operation's remaining basis in the property, $14,000, is recoverable over the "life" of those assets, starting with 2002 under the normal MACRS rules.

    In most cases, a sign business or professional can recover the full amount spent to acquire business property. The flexibility arises when the sign professional decides whether the business would benefit more from larger, up-front or first-year depreciation deductions or would smaller depreciation deductions over a longer period be more beneficial. Larger, first-year write-offs admittedly help reduce the out-of-pocket costs for acquiring business assets. A start-up or unprofitable sign business expecting increased income in future years might be better served by depreciation deductions in those more profitable years.

    When improvements are made to leased business property, their cost is generally depreciated under the MACRS rules in the same manner as the MACRS deduction for the property itself would be calculated if the property had been placed in service at the same time as the improvement or addition.

    For example, the cost of replacing a roof on the building housing a sign business would be separately depreciated over 39 years using the straight-line method. If, upon termination of the lease, a lessee does not retain the improvement, loss is captured in the amount of the improvement's adjusted basis at the time of the lease termination.

    Generally, in order to claim depreciation, the taxpayer must be the owner of the property. A lessee who makes permanent improvements to business property, however, can depreciate those improvements.

    Most tangible property placed in service by a sign operation must be depreciated using methods prescribed under the modified accelerated cost recovery system (MACRS). Under MACRS, the cost of eligible property is recovered over a 3-, 5-, 7-, 10-, 15-, 20-, 27.5-, 31.5- or 39-year period depending upon the type of property. Prescribed recovery methods and conventions must also be employed.

    Under the rules, five-year property includes cars, light and general heavy-purpose trucks, qualified technological equipment, research and experimentation property, computers and peripheral equipment and office machinery. Seven-year recovery property includes office furniture, equipment and fixtures that are not structural components of a building. Personal property used in wholesale or retail trade or in the provision of personal and professional services for which a specific recovery period is not otherwise provided, is five-year property.

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    Component depreciation is not allowed under the standard, no questions asked Modified Asset Cost Recovery System (MACRS) created by our lawmakers. The U.S. Tax Court has ruled, however, that some elements of a building may be separately depreciated as personal property even under MACRS.

    The Internal Revenue Service recently agreed to go along with the Tax Court's ruling that the former investment tax credit rules apply in determining whether an item is a structural component or personal property. The IRS did not, however, go along with the Tax Court's complete finding about what was personal property under the rules.

    Under our basic tax rules, the cost of the most buildings, or nonresidential real property as they are labeled in the tax laws, placed in service today, must be recovered over a period of 39 years.

    In the case Hospital Corp. of America v. Commissioner, 109 T.C. 21 (1997), the Tax Court considered whether various items in the taxpayer's building were structural components of the building or whether they were Section 1245 property qualifying for a much shorter recovery period. According to the Tax Court, "an item constitutes a structural component of a building if the item relates to the operation and maintenance of the building."

    Among the items that were found to be Section 1245 property were: electrical distribution systems, television wiring, telephone equipment, carpeting, vinyl wall and floor coverings, kitchen plumbing connections and exhaust hoods, patient corridor handrails and accordion-style room dividers. According to the court, these items either related to HCA's business of furnishing medical services, did not relate to the operation or maintenance of HCA's buildings and were not intended to be permanent.

    What's more these assets, as Section 1245 property qualified for a fast five-year recovery period. That five-year recovery period also makes them eligible for the "bonus" depreciation under the new tax laws.

    Depreciation begins in the tax year that an asset is placed in service and ends in the tax year that it is retired from service or is fully depreciated. Generally, an asset is considered placed in service when it is in a condition or state of readiness and availability for a specifically assigned function.

    Under MACRS, one-half year's depreciation is generally allowed, regardless of how long the property is held in the year it is placed in service or disposed of, unless the mid-quarter convention applies. A mid-quarter convention applies to all property, other than real estate, if more than 40 percent of the aggregate bases of that property is placed in service during the last three months of the tax year.

    SECTION 179
    An expense deduction is provided for sign professionals who elect to treat the cost of qualifying property, called Section 179 property as an expense rather than as a capital expenditure. The small business expensing election under Section 179, is $24,000 for 2001 and 2002. It's scheduled to rise to $25,000 in 2003.

    Property may qualify for both the 30 percent depreciation bonus and the Section 179 expensing election. Remember, however, only so much investment is permitted. The dollar limitation is reduced dollar for dollar for each dollar of the cost of qualified property placed in service during the tax year over $200,000. Amounts disallowed under the rules this year, may be carried forward. Naturally, the total cost of property that may be expensed for any tax year cannot exceed the total amount of taxable income derived from the sign business.

    A loss may be allowed for the abandonment of a depreciable asset in the amount of its adjusted basis if the sign professional or business manifests an irrevocable intent to abandon (discard) the asset so that it will neither be used again by the sign operation nor retrieved for sale, exchange or other disposition.

    Since many of the depreciation provisions of the new tax law apply to property placed in service after September 10, 2001, or in tax years ending after that date, many sign businesses can qualify -- depending on the tax year and depreciation conventions used -- on their 2001 tax year return. In many cases, amended 2001 returns will need to be filed.

    Whether involving the bonus depreciation deduction or standard first-year write-offs under the Section 179 expensing election or the basic recovery under MACRS, every sign professional should carefully weigh the benefits of depreciation -- and its alternatives. Tax write-offs, when they are most needed, can be the result.

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